Tom's Blog

As a CPA and wealth strategist, I'm often asked by new business owners and investors about the best way to handle their bookkeeping. Should they do it themselves or hire a bookkeeper to handle it for them?

This is a more difficult question than you might think. On the one hand, many of you have heard me say that the most expensive words in the English language are, "Do It Yourself." And bookkeeping is not exactly a difficult task. There are lots of bookkeepers out there who charge anywhere from $15 to $40 per hour. I'm sure you could find them on e-lance or other outsource networks.

The difficulty comes from the communication of information from you to the bookkeeper. It's one thing if the bookkeeper is "in-house," that is, they pay your bills and handle a lot of your transactions. In this case, they will have most of the information they need from the source documents and they should have a pretty good understanding of your investing and/or business situation, i.e., what the bills are for (so where to classify the payments). Of course, if you take this option, you will want to have good internal controls in place so the bookkeeper cannot misappropriate (i.e., embezzle) your money.

However, if they are not in-house, but are instead just recording the information after the fact, it gets a little more difficult. I have been wondering for years why this is so challenging for a bookkeeper. We had so much difficulty finding a bookkeeper that could do a good job for clients, that a few years ago, we created our own bookkeeping company. Even with our own company, though, we could not always get the bookkeepers to produce accurate information. We ended up disbanding our bookkeeping service. It wasn't profitable for us and our bookkeepers were not doing a good enough job for our clients.

I finally came to a conclusion that the reason accurate bookkeeping is so difficult is that it is a matter of communication between you and the bookkeeper. You know what the bills are for, but this may not be evident just from the documents you provide. So the bookkeeper asks you questions about what every bill is for and where it should be categorized in your books. Then you start wondering why you are paying them if you have to tell them how to do their job.

The reality is that bookkeepers tend to have difficulty making judgment calls about where to classify a payment. And clients tend to get upset when payments are misclassified. This can be a no-win situation for both parties.

My conclusion is that for most investors, it's probably easier and less time consuming to do your own bookkeeping. You can pay your bills on line; most of them you can even have the bank pay automatically. Then, you can set up Quickbooks to automatically classify recurring payments to the right account. I spend about 30 minutes a week paying bills and doing my bookkeeping. And I have three companies. So I really take about 10 minutes per company per week.

Of course, I have been doing accounting for many years and I understand it very well. And, I have set up the accounting properly. The good news is that you, too, can learn how to do this and it doesn't take much time. At ProVision, we are in the process of creating two learning modules for bookkeeping and accounting. Look for them to come out in the early Fall on our Products page at http://www.ProVisionWealth.com/products. And don't be afraid to call our office at 866.467.5809 for help with your accounting set up.

Whether you do your own bookkeeping or hire someone, be sure to learn the basics so you can know that you have accurate records. You need these records to be accurate so you can get good information from them for your investing and business needs, as well as for the IRS and the bank.

Please let me know your bookkeeping experiences and whether you have had more success doing it yourself or outsourcing it. I would be very interested.

Warmest regards,

Tom

Craig asks another question, this time about paying expenses out of a sister company or personal account.

Q's about the do's and don'ts during business set-up of using personal credit cards-then writing a check from the business to pay us back. As long as we write a check from "personal acct" back to the business to cover the "non-business" expendatures is that OK? OK to use our airmiles, personal cc for business purchases and then reimburse ourselves with company check? What is the proper way to loan your new LLC/C-corp money from your personal accounts and then get reimbursed months down the road with interest?

A: First, it's always okay to pay business expenses with a personal credit card and then get reimbursed later from the company. You should prepare an expense report just like you would if you were employed by an unrelated company like IBM. You do have to meet certain rules, as you must have an accountable plan. Talk to your ProVision Tax Coach about this.

It's not okay, however, to pay personal expenses from your company account. The problem is that the IRS looks at this as an abuse and may argue that your company should not be respected as an independent entity. Instead, you should distribute funds to yourself, either as salary or a distribution, and then pay your expenses from your personal account. Remember, that you must always treat your company as a real business, not as a personal bank account. So pay your personal credit card from your personal account and seek reimbursement from the company, not the other way around.

As for the loan to the company, I suggest you do a formal loan agreement between you and the company, specifying an appropriate interest rate and payments terms. The interest rate must be no less than the Applicable Federal Rate for that loan. Contact your ProVision Tax Coach at tc.tempe@provisionwealth.com for more information about the structuring of the loan and the interest rate for the loan.

Warmest regards,

Tom

Craig asks a very interesting question about his automobile expenses:

Q: Presently I am taking the standard cents per mile deduction on my vehicle under my current occupation. Due to the AMT, my accountant tells me I net back only about 2% of ALL of my expenses. How can I use my C-corp or LLC more for these expenses.

A: The issue here is that if you are an employee and you have unreimbursed expenses, such as automobile, travel, meals or other, they are only deductible as miscellaneous itemized deductions (MID) on your Schedule A. The problem with this is twofold. First, they are subject to a 2% floor, i.e., you only get to deduct MID to the extent they EXCEED 2% of your adjusted gross income (AGI). Second, they are not deductible at all for AMT purposes.

The solution is to incur these expenses as a business, not as an employee. Let's say, for example, that you are in sales. Your company allows you to either be an employee or an independent contractor. As an employee, you lose the deductions. But as an independent contractor, all of a sudden these expenses become fully deductible, not subject to either the 2% or the AMT limitations.

Of course, there are other issues with becoming an independent contractor that you need to consider, including loss of benefits and Social Security taxes.

Just paying these expenses out of an LLC or corporation will not solve the problem, so long as you remain an employee. The reason is that they expenses relate to your employment and not to your LLC or corporation. You can only deduct expenses in your LLC or corporation that belong to that entity. Paying someone else's (in this case, your) expenses is not allowed as a deduction by the IRS.

Contact your ProVision Tax Coach for tax strategies to take advantage of the independent contractor status. There are ways to minimize the Social Security taxes and even the loss of benefits.

Warmest regards,

Tom

Thanks to David for giving the following feedback to our recent email entitled, "The HUGE difference between tax and legal terms and how it impacts your tax strategy."

Good point Tom.

Even though we have to consider taxes, and asset protection together, we also need to remember it's a joint effort by the CPA, and Attorney. It's good that a CPA find the best tax advantages, and consult with the Attorney for the best asset protection for the individual situation. A CPA that keeps an eye on the big picture is a bonus, but one that ignores tax advantages because of well known legal advice is a drawback.

After reading the part "I find that those who have the most successful tax strategies are those who understand the basics thoroughly. And by that I mean they know enough to know when to ask questions and seek expert advice. " I agree totally. Will I have access to the "Fundamentals in the Entity Formation section of Tax Mastery in Wealth Strategy U"

A: There is a tremendous amount of free information in Wealth Strategy U under the Tax Mastery section. Just log in at http://www.provisionwealth.com/wealthu. For even more information about entity formation, you might want to try our recently released home study course entitled, "How to Create Your Own Tax Savings By Building the Perfect Tax Structure: 5 Strategies to Selecting Entities that Reduce Your Taxes." You can get this through our website at http://www.provisionwealth.com/products.

Warmest regards,

Tom

Alphonso asks the following question: Hi Tom, thanks for keep in touch with me. Your Information is so valuable and very welcome. At this time, I have some questions about income. How can I split my income as a 1099? I understand we need to manage and organize every penny, so I am splitting in this way: 10% Tith 15% Tax Savings 15% Advertising 30% Personal Income 30% Business Expenses Any suggestion? My other question is about my wife. She is W2. How you suggest to split her income? Thanks

A: I'm not exactly sure what Alphonso is asking, but let me suggest there could be two different questions here. The first is the best allocation of income to various expenses. I think that is a question for your Wealth Strategist. At ProVision, we believe that each investor should develop their own personal wealth strategy that is unique for them. Visit http://www.provisionwealth.com/wealthstrategies.asp for more information or see our wonderful Wealth Strategy home study course, Financial Freedom Now! at http://www.provisionwealth.com/products.

The other possible answer to the question has a tax angle to it. Could a person split their 1099 income between multiple companies to lower tax brackets? The answer very well could be "yes." If different companies perform different tasks for a client, then the client could pay each company for that service rendered. This could be especially beneficial if one of the companies were a "C" corporation. C corporations have their own tax brackets and the first $50,000 is ordinarily taxed at a 15% tax rate. Look for more on this strategy when we release our home study course on using C corporations. It will be released in the next few months, so be sure to keep a look out for it. We recently included it with the package we released to the Rich Dad Forum participants and it was very well received.

Remember that permanent tax savings, such as lowering tax brackets, are one of the key secrets to a successful tax strategy.

Warmest regards,

Tom

For those of you keeping track, last weekend was my triathlon in Rocky Point, Mexico. My goal was to improve my time by 30 minutes. A pretty aggressive goal. Most of this was to come from the run portion. My good news to report is that I did trim substantial time off my run (about 20 minutes), despite my lack of run training. While not meeting my goal, it went a long way towards my goal and I hope to get the additional 10 minutes off my run by my next triathlon. I attribute most of my run success to the socks that I got from http://myfootguy.com. These are amazing socks that provide tremendous ankle and foot support. My gimpy ankle was just fine after the 10k run. Amazing!

The bad news is that my swim and bike were slow this time. I'm not sure why, but I am sure that I need to pick up my training and I need to get a coach. I believe a coach will not only help me set goals and be accountable, but will give me advice on how to better train and how to race better.

I think I was a little worried that I might run out of gas on the run if I pushed the swim or the bike too hard. This goes to the mental part of racing. I simply don't know enough about my body and what to expect (how I should be feeling during each part of the race). A coach would be extremely helpful in this regard and I found one while mingling with the other triathletes in Rocky Point.

Of course, wealth building is very similar to triathlon training. We have to set goals, be accountable, and continue to focus on what we are trying to accomplish. We also need a coach. You have heard me say it before, but I'm saying it again anyway. A wealth coach should help you with the mental aspects of wealth as well as giving you advice, providing accountability, and helping you set goals.

I am pretty anxious to get started with my triathlon coach. I suggest you get started with your wealth coach. Find out more about wealth coaching on the ProVision website at http://www.provisionwealth.com/wealthstrategies.asp.

Warmest regards,

Tom

My friend, Dave Sullivan, asks the following question about "component" depreciation:

I was wondering if rental real estate held in an LLC can use component depreciation for accelerated paper losses, and a resulting higher monthly cash on cash return? I read component depreciation could be used in Robert Kiyosaki's real estate book, but then saw this online:

"Component depreciation
At the end of a seminar to a religious group, he says he (Robert Kiyosaki) recently did a real estate deal where he got a 17% cash-on-cash return and that "there's 24% component depreciation on the property." Really? Gee, and I thought component depreciation was explicitly outlawed by the Economic Recovery Tax Act of 1981. Actually, I'm sure of it. It's right there in Section 168(f)(2) of the Internal Revenue Code."

A: I'm not sure where Dave read this comment about component depreciation, but the person making the comment is simply misunderstanding the difference between component depreciation and cost segregation. While it is true that "component" depreciation was eliminated with ERTA (the 1981 tax act), we can still do what we now call "cost segregation." After the 1986 Act, the IRS initially believed that cost segregations were still outlawed. However, this position by the IRS was overturned by the courts, notably in the Health Corporation of America (HCA) case in 1993. With this case, the IRS finally gave in and formally announced that it would allow cost segregations for property placed in service after 1986. There is even an IRS audit guide that specifies how a cost segregation must be done in order to be allowed by the IRS.

A cost segregation, while technically not component depreciation, has the same effect as component depreciation, just under the "new" (i.e., post-ERTA) depreciation tables. This means that we can segregate the costs of the building, the building fixtures (e.g., cabinets, ceiling fans, window coverings), and land improvements and depreciate them under the appropriate rates for those types of items. Typically, a cost segregation will result in much more depreciation in the early years of building ownership which can put a lot more money in the pockets of the owners through lower taxes.

At ProVision, we recently developed a home-study course about how to maximize your depreciation deductions. Look for it's release in the coming weeks at http://www.provisionwealth.com/products.

So when you are buying a building, consider performing a cost segregation following the IRS guidelines. IRS guidelines require an outside professional, such as ProVision, to do the cost segregation. Contact us at 866.467.5809 or cs@provisionwealth.com for more information on how we can help you maximize your depreciation deductions.

Warmest regards,

Tom

Chris asks the following excellent question about the consequences of qualifying for real estate professional status:

If I elect aggregation for RE professional status for 2 rentals, what are the implications when I sell? One possible scenario in this current market would be that I incur a loss on one property (even with recapturing depreciation!) and a gain on the other, presuming I sell both in the same tax year.

A: As with most tax questions, the answer is "it depends." It depends on whether you have always qualified as a real estate professional. If so, then you simply have gain or loss in the year of sale and that gain or loss is treated as a Section 1231 gain or loss. See your tax coach for more on the consequences of Section 1231 gain or loss (generally positive).

If you have not always been a real estate professional, you may have unused passive losses relating to these properties. If you sell the properties in a fully taxable disposition (e.g., there is no gift or 1031 exchange involved), you will free up these unused passive losses to be available for use against other income (including any gain from the sale).

If you sell one, but not the other, you will not free up any passive losses. This is because you have not disposed of the entire property (which, because of your aggregation election now includes both properties). You will not free up the losses until you dispose of the other property. The result is that you could end up with these passive losses trapped and unused for years and years.

For this reason, I strongly recommend you consult with your tax coach to determine the best tax strategy even before you make the aggregation election for the first time.

For more information on how to be a real estate professional for tax purposes or the consequences of doing so, see our new ProVision education product, How to Uncover the Hidden Cash Flow from your Real Estate at http://www.provisionwealth.com/products.

Warmest regards,

Tom

The great question of the world is, "How do I find happiness?" Some people seem to think happiness comes from material possessions. Others seem to think it comes from fame. Still others believe it comes from love and family. While there can be very happy moments from any of these and particularly from love and family, true and lasting happiness can only come from gratitude.

Gratitude cures a multitude of ills. When I was a missionary in Paris, I spent several months in the suburbs south of Paris. This has never been a very well-to-do part of the city. Interestingly, I found both very happy and very miserable people there. Those who were miserable tended to blame others for their misfortunes and were angry at the world for not giving them more.

On the other hand, there were several people I met who were extraordinarily happy, though they had very little. These people were very thankful for what they did have. They were thankful for their family, their friends, their health. They did not complain. They were at peace.

How is it that I found two such completely oppositite attitudes int he same place among people in the exact same circumstances?

It became clear to me that the difference between the two groups related primarily to their attitude about life. On the one hand, there were those who were angry at life and felt they had been cheated. On the other hand were those who were grateful for what they did have.

I have found this situation over and over in my life. People who are truly happy tend also to be those who are the most thankful for their blessings, regardless of their current station in life. Those who were unhappy were jealous our upset because they didn't have something they wanted.

I notice this in my own life as well. When I focus on how much I have been given, I am less worried about what I don't have. I also tend to focus more on how I can help others. And helping others is where true peace and contentment are derived.

What does this have to do with wealth? Everything! Wealth includes not only monetary success, but also spiritual, emotional and physical success. And we tnd to be so much more successful in these areas when we are grateful. Interestingly, I also find that my financial wealth grows as well when I am most grateful. When I can get ouside of myself and focus on helping others, giving back, is when the money seems to flow.

So don't be afraid to say a prayer of thanksgiving from time to time or to tell your spouse or your children how much you appreciate them. It will have a tremendous impact on your life.

Thank you for letting me share with you.

Warmest regards,

Tom

On Tuesday (Tax Day), John McCain announced his idea for how to simplify the tax filings for mllions of people. Finally, a workable idea!!! His idea is quite simple and would solve many problems. For those of you who didn't hear about it, here it is in a nutshell.

Create an alternative tax that is optional (not mandatory like the AMT). The alternative tax would be a flat tax, with two tax rates, a generous standard deduction, and nothing else. Taxpayers would have the choice of filing under the regular tax system or the alternative system.

This solves many problems without creating the remarkable complexity that comes from a consumption tax (e.g., national sales tax) or other "flat tax" proposals. Because you have a choice, you would be able to take the complex route of the regular tax, using a firm like ProVision to handle your tax filing. If, on the other hand, simplicity is most important to you, you can simply use the flat tax and file a postcard-type return.

What I like about this proposal is that it should eliminate many of the complainers about the current system being too complex. They would have the opportunity to use the simple form. At the same time, it's not a massive overhaul of the current system and so is politically doable, as no one loses. It should allow the IRS to reduce it's audit staff (especially office audits). Finally, it allows the government to continue using the tax system to encourage investment in real estate and business. (Personally, I'm not sure I care whether the government uses the tax system for economic, social and energy policy. The government sure seems to like it, though.)

The only downside I can see is that it would take the pressure off the government to do a massive overhaul of the current system. At this point in history, though, it seems almost impossible to undo decades of complicating the tax system. The tax system is woven throughout our entire economy. So I think that Mr. McCain's proposal is a very good step in the right direction.

One other aspect of John McCain's proposal that I really like. With a flat tax, any time the government wanted to raise or lower taxes, it would be very obvious, since it would have to include a rate change or a change to the standard deduction. It couldn't be hidden like the haircuts we have on Schedule A (itemized deductions) or the income limits on certain tax benefits or the alternative minimum tax.

There are still many issues that would have to be ironed out, such as which income is taxable, but let's give Mr. McCain a round of applause for coming up with a reasonable step in the right direction towards tax filing simplicity for the average, middle-class American.

Warmest regards,

Tom